“Lease Accounting – Upcoming Changes to Affect Lessors and Lessees” by Mark Batey, CPA | Senior Manager – Audit & Assurance
The Financial Accounting Standards Board (FASB) after years of deliberation finally issued a new accounting standard just over a year ago (February 2016). This new standard – Accounting Standard Update (ASU) 2016-02 is the result of over a decade of discussions and was issued as part of its convergence project with the International Accounting Standards Board. The accounting standards update aims to improve financial reporting about leasing transactions and will affect all companies that lease assets such as real estate, restaurants, construction and manufacturing/distribution companies.
Does it Affect both Lessors and Lessees?
Yes the new standard applies to both lessors and lessees of leasing transactions. However, for lessors it is generally “business as usual”. In other words, the new accounting standard makes little fundamental changes from current accounting rules and guidance other than to some targeted improvements that are intended to align, where necessary some accounting changes with the new requirements by lessees as well as with the updated revenue recognition guidance that the FASB issued in 2014.
The most significant impact of this new standard will be seen by those companies that are leasing assets (the lessee). Although there will continue to be two types of leases (finance and operating as they are called in the new standard), the accounting and disclosures for each type will now be more similar than they were in the past.
Finance and Operating Leases will Now both Affect the Balance Sheet
For companies that currently have leases accounted for as a capital lease (as previously mentioned will be a finance lease under the new standard) the accounting will be substantially the same as under current accounting rules. In other words, the item being leased will be considered an asset of the lessee and the obligation owed to the lessor will be a liability. Operating leases (no change in name under the new standard) will be accounted for in both the income statement and statement of cash flows similar with existing accounting rules. However, unlike current rules where the future obligation/commitment related to the leased asset is only a disclosure in the footnotes, the new rules require balance sheet recognition. For any operating lease that has a term in excess of twelve months a company will have to record the present value of the remaining (future) lease payments as a liability and a corresponding amount as an asset.
Why does the FASB want a Company to Record an Asset for something it does not Currently or will Never Own?
The FASB and others believe that current accounting for operating leases does not allow for comparability and transparency among companies. The new standard is intended to help investors and other users (such as lending institutions and other creditors) of financial statements have better information to evaluate an organization’s rights and obligations related to lease transactions since it will be included in the balance sheet and not just a future commitment disclosed in the footnotes. In addition, the footnotes will require additional qualitative and quantitative disclosures.
Organizations Still have Time but don’t Wait too Long!
The new accounting standards go into effect for non-public companies for fiscal years beginning on or after December 15, 2019 (this would be 2020 for companies that have a calendar year accounting period). That may seem like many years (three or possibly four) but planning should start sooner than later for the following reasons:
- For companies that issue comparative financial statements the balance sheet for 2019 will have to retroactively recognize the assets and liabilities related to operating leases when the 2020 financial statements are issued. Therefore, an organization will need to have the information available as of January 1, 2019.
- Leases can be an important element of debt covenants or other contractual arrangements. Some of these could be coming up for renewal in the very near term but could be in effect when it is time to implement the new lease accounting rules.
- The new accounting standard does allow for early application thus an organization may find it is in its best interests to implement the new standard as early as 2018.
- Depending on the number and the complexity of the lease transactions a company may need to have its internal IT department write programs to help gather the information that will be required for some of the qualitative and quantitative analysis.
The new accounting rules will affect almost all organizations, some more than others. Please contact your trusted advisor at Apple Growth Partners for more information on how this new standard will affect your organization.